A Syllogism About Tax Cuts

Daniel Gross finds Greg Mankiw and Robert Carroll asking a leading question:

Daniel Gross: July 23, 2006 - July 29, 2006 Archives: BURYING THE LEDE: Gregory Mankiw and Robert Carroll have an op-ed in the Wall Street Journal today on the Treasury department's study on dynamic scoring and tax policy.

They posit three lessons:

1. "[A] permanent extension of the recent tax cuts leads to a long-run incraese in the capital stock of 2.3%, and a long-run increase in GNP of 0.7%."
2. Cutting taxes on rich people -- i.e. reducing capital gains and dividends -- juices the economy more than cutting taxes on middle-class and poor people.
3. Without actually saying so, they argue that the way the Bush administration -- of which Mankiw was a part -- and the Republican Congress have gone about cutting taxes will actually harm long-term growth.

Lesson No 3: How tax relief is financed is crucial for its economic impact.

Like all of us, the government eventually has to pay its bills. In technical terms, the government faces an intertemporal budget constraint that ties the present value of government spending to the present value of tax revenue. This means that when taxes are cut, other offsetting adjustments are required to make the numbers add up.

The Treasury's main analysis assumes that lower tax revenue will over time be accompanied by reduced spending on government consumption. But the report also shows what happens if spending cuts are not forthcoming. In this alternative scenario, a permanent extension of recent tax relief is assumed to lead to an eventual increase in income taxes.

The results are strikingly different. Instead of increasing by 0.7% in the long run, GNP now falls by 0.9%. Tax relief is good for growth, but only if the tax reductions are financed by spending restraint...

What proportion of students will be able to follow the syllogism?

• Tax relief is good for growth only if the tax reductions are financed by spending restraint.
• The Bush tax reductions have been financed not by spending restraint but by borrowing.

Therefore:

• The Bush tax reductions have been bad for growth.